Buffeted by the economy and regulatory overload, medtech companies adjust to life in the next decade.
If 2009 was a year of massive uncertainty for companies doing business in the medical products sector—and it certainly was—then 2010 has to be considered a year spent making adjustments to meet the new realities thrust upon them.
The uncertainty of last year concerning what form healthcare reform might take has been replaced by the knowledge that such legislation now is in place, with phased-in segments of that sprawling piece of legislation seemingly scheduled to run from here to doomsday. And the reality, according to those interviewed by Medical Product Outsourcing for this look at the year in review, is that save for the so-called medical device tax that is scheduled to go into effect in 2013, healthcare reform probably won’t be of significant impact to the sector going forward.
Jason Mills, a San Francisco, Calif.-based medtech analyst for Cannaccord Genuity, told MPO that in regard to healthcare reform, “the gives-and-takes at this point are difficult to tell. Healthcare reform really doesn’t play out for a couple of years. Health reform in general is going to happen, but I don’t necessarily see that as one of the major challenges over the next couple of years.”
But the device tax continues to be worrisome to those involved in the sector. Josh Makower, innovator, entrepreneur and venture investor, said that the device tax “is a tax on revenue—not profits. Many small medical device firms don’t turn a profit until they are at about $100 million in sales. This would mean investors would have to pay a tax to the government from the dollar one of revenue, simply to have the privilege of losing money.”
Makower, who is a venture partner with New Enterprise Associates as well as CEO of ExploraMed Development, a West Coast-based medical device incubator, added, “Venture investors will react very negatively when they realize that their dollars are not funding progress for the company but are simply being paid directly to the government.”
Joseph Panetta, president and CEO of Biocom, a San Diego, Calif.-based group that describes itself as the world’s largest regional life-sciences trade association, said of efforts to at least end up with an exemption to the device tax for smaller device companies, “We’ve been working closely with MDMA [the Washington, D.C.-based Medical Device Manufacturers Association] on it. I think they’ve been pretty vocal on this. There’s an opportunity there for that to be turned around.”
Looking ahead to 2011, some expressed a bit of optimism, but most shared the view of Mills, who said, “You’re hearing companies talk a lot about procedures being delayed, and I think that probably continues.”
He said that from a Medicare standpoint, “You’re already seeing them get more aggressive and more cognizant of what they’re paying, looking to reduce waste in the system, i.e., unnecessary procedures that are done.”
Bottoming Out Leaves Sector Depressed
Asked to assess the status of the sector as 2010 draws to a close, the respondents were in accord almost uniformly: Times are tough, and things don’t look to get a lot better in 2011.
Mills said, “If you take a look at the largest medical device markets, they are really in tough shape today as it relates to their growth trajectory. They’re seeing impacts from the overall economy in terms of procedural growth in some cases; they’re seeing a negative impact in many cases from their market being somewhat mature; they’re seeing price pressure. There is a multitude of challenges that are faced by the competitors in these large markets, especially as it relates to price pressure.”
But he said there are some smaller markets that are under-penetrated, “where new clinical data has changed the paradigm in relation to treating patients that have certain diseases such as heart failure or aortic valve disease.”
Howard Root, president and CEO of well-performing, small-cap firm Vascular Solutions, based in Minneapolis, Minn., said, “It’s the toughest market condition of my career in medical devices. It’s a combination of from the reimbursement side we’ve got Obamacare looking at making massive changes, not all of which we fully understand yet. We’ve got the regulatory side making changes in the 510(k) process certainly and looking to make other changes both structurally and operational. And then we have the financial markets, which aren’t fully recovered but have come back a little bit, but still have some depressed valuations for small medical device companies.”
Sharon O’Reilly, a longtime industry watcher as editor of MedPro Month and Medtech Insight, describes the industry’s current state of mind as “downbeat.” There is a still a great deal of uncertainty going forward with the economy—i.e., recession, unemployment—and when it will start to recover as well as what the full impact of healthcare reform will be on the medical device industry,” she said.
O’Reilly, whose newest firm, BioMedGPS LLC, is based in Irvine, Calif., added, “Companies are reassessing their businesses and finding ways to rein in costs and operate according to new rules that are still not well-defined.” She said that companies are starting to employ technology to streamline internal processes that drive efficiencies and increase productivity so they can do more with less. One area ripe for innovation, O’Reilly said, is in the way companies track and exchange market information. She mentioned her company’s SmartTRAK Online Business Intelligence tool that provides up-to-date information on companies, markets and products, and allows users to obtain a global view of the competitive landscape. SmartTRAK, according to O’Reilly, is transforming market research from being a labor-intensive process to one that is dynamic and interactive.
Baiju Shah, president and CEO of Cleveland, Ohio-headquartered Bioenterprise, a business formation, recruitment, and acceleration initiative designed to grow healthcare companies and commercialize bioscience technologies, said that in 2010, “we have gotten past the healthcare reform debate. There are still a lot of unsettled issues and new uncertainties,” he noted, “but the economy has found solid footing. I feel more optimistic for 2011.”
Even more upbeat was Joe Kiani, chairman and CEO of Masimo Corp. in Irvine, Calif., a developer of highly innovative non-invasive patient monitoring technologies. He told MPO: “2010 has been a very good year for us—obviously not as good as 2008 but a lot better than 2009. That’s probably the same for all my colleagues, but it’s certainly true for us. As for 2011, yes, we are optimistic. I think that short of the next shoe dropping in the financial markets, there’s nothing to indicate things are going to get worse in 2011.”
Joining him on the more optimistic side was Panetta, who noted, “There is more of a demand in the medtech sector than there is in the biotherapeutics and pharmaceutical sectors simply because the return on investment is much shorter than in the biotech sector, so a lot of investment has migrated from the therapeutics and pharmaceuticals sector over into the medtech sector.”
Makower put it most succinctly: “While I remain inspired by patients and the many opportunities we have to improve their care, I am deeply troubled about the direction our U.S. regulatory system is heading.”
New Realities Settle in For a Stay
Many in the industry are making reference to what they like to call the “new normal.” Companies now are settled in and are past the uncertainty of healthcare reform. There are a lot of different meanings as to “new normal,” but a common one is “OK, it’s a tougher environment for us to work in, it’s a tougher regulatory environment, hospitals are much tougher negotiators on price, and we’ve had to make cutbacks in our business operations, but that’s just the way it is.”
Shah said, “There’s a frugality that is pervasive throughout the sector at this point, and it starts with healthcare payers and cost pressures that have cascaded down to the buyers and then to the technology companies. All of that is creating the ‘new normal.’” The other change he claims is not yet fully internalized in the U.S. sector is the forces of globalization. “So we have this new normal, but what we’re starting to hear more discussion of in the investment community is the innovation that is starting to occur outside the U.S., as well as the growth of markets ex-U.S. in terms of new medical technology,” he said.
Kiani agreed that a “new normal” has settled in. “That’s really a good way of putting it. I’m probably more optimistic than most people given that I’m an entrepreneur, and we wouldn’t do what we do if we weren’t overly optimistic, but I think this is the way it’s going to be. There are problems with the current shape of things, but I think they can be improved. So, hopefully, the new normal may be with us for a while, but it doesn’t mean it’s not going to get better long-term.”
O’Reilly added that there “is no question” that industry has changed and it is unlikely that it will ever go back to the way business was done before. “Burdensome regulations are likely to be the norm on all fronts and even more onerous for physicians and manufacturers as comparative effectiveness kicks in,” she noted.
Root agreed with the new-normal assessment. “It has gotten to this level, and it isn’t going to come back. It isn’t a cyclical trough; it is what it is and it’s going to be modest changes from here on up or down, but not what we saw in the 1990s.”
Regulatory Uncertainty a Dominant Theme
Mark DuVal, president of DuVal & Associates, a Minneapolis, Minn-based firm that focuses on U.S. Food and Drug Administration (FDA)-related issues, may spend more time in face-to-face contact with the FDA than anyone else associated with the medtech sector. On the topic of regulatory uncertainty, he said, “To a great degree we find that a lot of those changes have been informally implemented over the last year, year-and-a-half anyway. I’m at FDA every two to three weeks, on behalf of somebody negotiating an IDE (investigational device exemption) or a 510(k) or PMA (premarket approval application), so at the trench level I can see the practical impact of what’s going on.” (Editor’s note: For a more in-depth examination of the current storm swirling around the FDA’s 510(k) changes, turn to this edition’s regulatory feature on page 44.)
DuVal reported that the FDA informally has implemented a lot of what they’re talking about. “They will deny that publicly, but they fact is that anybody who is taking a 510(k) through the system is seeing some of these real-life debates about the use of split predicates or multiple predicates or escalating data requirements,” DuVal said. “One thing that I can say on the positive side is that the FDA really seems to be getting itself organized in a way that interfaces with the industry. I’ve had some really positive meetings in the sense that they’re a lot more organized, they’re a lot more crisp in the way that they’re run, I feel that we’re being heard more as far as presentation of our views, and they’re taking meeting minutes and issuing them—all of which is really good.”
However, he did note that the agency remains “very risk-averse” and often gets bogged down in “miniscule forms of risk” when evaluating a new product application.
He emphasized that the Office of the Ombudsman “is another bright spot” within the FDA’s Center for Devices and Radiological Health.
“David Buckles has turned out to be a terrific ombudsman,” DuVal said. “He clearly understands scientific issues and he actively intervenes to assist industry to make sure their arguments are understood. He can’t be an advocate for either side, but I do think he challenges the thinking on both sides, which is good. In my last five or six meetings, I think his behind-the-scenes work has made a difference in the discussion with review staff and
Overall, according to DuVal, it has been a very difficult time for the agency. He noted that the last two years had been “the most difficult” for his practice in working with the agency.
From his viewpoint heading a company that has to get product approvals from the agency, Root noted three types of changes.“One that we talk about a lot is structural changes, as in they’re going to change the 510(k) process. The second category—which I call operational changes—is how [the agency] interprets existing regulations, and those changes have already occurred, where the FDA is going back and imposing new testing requirements or new explanations required for things that hadn’t been requested over the past several years. And then there’s a third part—an attitudinal change—which also has already occurred.”
He expects PMAs to pose more difficulties to the long-term planning process over the next decade than changes to the 510(k) process.
“That uncertainty of what’s going to be there in three or four years and how a panel is going to decide three years from now based on a clinical trial today whether it’s a safe and effective device, that really hampers our ability to take big bets,” Root added.
Mills expects the uncertainty to continue, saying he doesn’t believe the FDA will respond quickly to industry’s calls for more certainty and clarity about the device approval process.
Makower believes that while the 510(k) system will not be completely dismantled in favor of the PMA process, he remains concerned by a lack of detail in the FDA’s proposals thus far.“Nothing has formally legally changed at the FDA, but predictability, transparency and reasonableness has in several areas been completely lost,” he said. “Thus, it’s hard to feel good about the proposals, even if a few may ‘sound good’ on the surface, because it’s not clear how they will actually be implemented – and implementation is everything.”
Kiani noted that the uncertainty is particularly problematic for small companies.
“It’s not affecting us as bad, but I’m hearing so many stories of promising young companies that were venture-backed just literally picked up and put [their technology] on the shelf until there is an FDA that’s kind of the way it used to be versus the way it is now. People just can’t afford to keep funding these requests for more data, more data, more data,” he said.
Panetta said the pendulum at the FDA has swung so far in the direction of risk aversion that products are not getting approved, approval is being delayed, or the number of additional mandates required for the approval process are “almost insurmountable.”
O’Reilly noted, “I cannot imagine that at the end of the day that the 501(k) approval process is going to get any easier, faster or cheaper for companies developing new products.”
U.S. Role in Innovation Threatened?
Asked about whether the impact of regulatory issues and the forthcoming device tax has U.S. firms planning to seek initial product approvals elsewhere, DuVal said, “I speak at a lot of investor conferences, and I have so many VCs (venture capitalists) come up to me who want to have private dialogue about my view of what’s going on with FDA right now. It’s a very depressed state because investment capital is way down.”
He said investors are willing to take the clinical risk—the success or failure of clinical trials—but they are less willing to tackle the regulatory risk given the perceived unpredictability of the agency. For example, according to DuVal, companies have noted that the FDA will change course in the middle of a new product submission after a clinical trial has been completed that was negotiated with regulators.
O’Reilly said all these factors—device tax, transparency, regulatory reform—are making it harder for medical companies to conduct business in the United States.
“Why spend $50 million to bring a product to market in the U.S. when you can do it for $5 million in a very developed country such as Germany, which has a less restrictive regulatory environment, favorable reimbursement and where the government will actually subsidize jobs for companies that establish their headquarters there?” she asked. “While products may still be developed in the U.S., companies will set up shop outside the U.S. and run their business from there.”
Makower said a secondary effect of the regulatory delays and escalating business costs in the United States is a flight of talent and jobs to other countries. The impact to patients is that they will not gain access to technologies created here in the United States for several years.“We truly are at risk of losing our leadership in this important sector,” he said.
While this trend is frustrating, it isn’t completely unknown to the industry, Vascular Solutions Root noted. He referenced David Kessler’s reign as FDA commissioner in the mid-1990s.
“We had that before when David Kessler was the head of the FDA, a time when they didn’t approve a single PMA in a year, and back then we’d always run over and manufacture our devices in Scotland or Ireland because you couldn’t export a device unless it was approved here, and we’d start selling it one to two—maybe three years—earlier than in the U.S.,” he explained. “Then there was a shift back when we were able to move up the FDA process a little bit. The CE mark [in Europe] came online and the approval process here and there was pretty equivalent, while Japan lagged behind the U.S. Now, I see a return to the old days where the FDA is uncertain; it’s more expensive; it’s certainly longer; and the CE mark is much quicker, so people will go back to the old way of launching first in Europe and then bringing it to the U.S.”
Bottom line, according to Shah: “The challenge that we have from an innovation perspective is that it gets back to the economics. Innovators and investors are not going to put their resources behind companies if they can’t earn healthy financial returns.”
Doing Business Elsewhere
As for companies making the choice to focus on doing business in Europe and other international markets, Panetta said there’s a concern among his association’s members that many companies and investors are talking about going to Europe first, where it’s much easier to obtain approval.
Kiani said Masimo’s approach started globally. “We want to help people all over the world with our innovations. From day one, we began in Europe and Japan. The international market, though, is going through some of the same financial problems as the U.S. So it isn’t as though there’s a country where business is booming that we all rush to while the U.S. recovers. With China and India, those are potentially very attractive markets because of the number of people who live there, but both markets have their own risks. We’ve been doing great in China, which is taking healthcare seriously. Beijing bought over 1,000 devices from us to do congenital heart disease detection for their newborns, based on a very strong study that came out of Sweden about how our products detect CHD (coronary heart disease).”
From Root’s perspective, international markets are growing faster than the United States. “Because we have good coverage in the U.S., we have some international markets that we’re not in,” he said. “In terms of growing procedures, the number of procedures internationally is growing a lot faster than the U.S.”
An international focus could be a market shift for device companies—medtech firms, along with developing innovative technologies also should be taking a global view from the start. Shah agreed, saying, “If you’re starting a company today, you have to have an immediate eye towards global markets. They need to orient themselves from the get-go toward those markets, which means different types of capabilities.”
Panetta said Biocom’s strategy is to build a bridge between Southern California and the life-science communities in Asia. In the last year, his focus has been on China and its rapidly growing life-science industry, along with the research community that is being created by the Chinese.
“There’s a huge market in China of 1.3 billion people who are going to be treated more and more through the efforts of the Chinese and their healthcare reform process,” he said.
M&A Activity Continues Apace
When asked about whether the near-record levels of smaller firms being gobbled up by the larger players in medtech would continue, Mills replied, “When we look back at 2010—probably through 2012—this could turn out to be, in retrospect, one of the more robust time periods in medical devices that we’ve seen in 20 or 30 years.” The reasons, he noted, are many. “First, you have large-cap companies that are flush with cash; they’ve done a very good job of controlling their operating expenses and a fairly good job of driving net income growth in lieu of having strong revenue growth in many cases, so they’re building cash. And by the same token, many of the markets on which they have relied to generate revenue and earnings in the past are in a waydinosaur growth markets.”
Mills does not see growth re-accelerating in some of the large markets anytime soon. In order to drive growth, large companies will need to be acquisitive.
“They need to acquire in markets where the denominator is relatively large in terms of the patient population and the numerator is relatively small, i.e., the penetration is low and the paradigm has changed in terms of outcomes shown by next-generation medical devices,” he predicted.
Makower said the existence of a healthy mergers and acquisition market can, in part, help offset the lack of exit opportunities through an initial public offering (IPO) in the minds of the venture community. “But because there is no IPO market, the exit values are certainly under pressure and, for the most part, lower. If a firm can develop a stand-alone, profitable and rapidly growing enterprise, that can still demand top dollar. Those with product-line extensions and smaller innovations will find values very challenged.”
Jim Stommen, retired editor of industry publication Medical Device Daily, is a freelance writer focusing on the medical product sector.